Citizens Financial Group, Inc. (CFG) Earnings Call Transcript & Summary

Absolutely. So just to be clear, this is not part of the survey, but this is historical, global announced M&A data that we look at. And really, the point of it is that when we talk to our clients, it's to remind them that M&A is a secular growth business, but it's also quite cyclical. And so if you look at kind of the chart here, you see that red dotted line, which is kind of that long-term baseline or trend line, but then you see the actual M&A volumes kind of well above it and well below it over time. But the good news is that over time, M&A tends to grow in the upper single digits to low double digits just because all the reasons we're talking about is such an important strategic tool for companies to grow their businesses. And so as we think about the market today and kind of where we've come from, 2021 was by far a record for announcements. And we all know that, that type of environment was probably not normal. And so we went from one extreme in 2021 to complete other extreme, which you see in kind of the last 2 dots on the far right of the table, where 2022 and 2023 are well below that historical trend line. If you think about history, it generally takes 1 to 2 years from peak to actually trough, which would put us into 2023. So our base case is 2023 was the trough, and then it generally takes 1 to 2 years to get back to the baseline. And to just get back to that historical trend line, let alone anything that's, call it, frothy, there needs to be about a 40% increase in announced M&A activity just to get there. So our expectation and our base case is that 2024 is a transition year towards that baseline. And so we think that you would probably see a 20% or so increase from the 2023 level and then another roughly 20% getting you into 2025. And so there's a lot of momentum coming off of 2023 trough. And I think it all kind of comes back to the optimism that's building and then the reasons why companies are thinking about doing M&A today. But I think this just kind of gives that level set of where the market came from and then where we are today and what getting back to normal will look like.

Thanks, Devin. [Operator Instructions] Okay. So let's move on to our next slide. So I really like this slide, reasons for expected deal flow increase in 2024. Dave, I want to turn it over to you, and I'd like to talk a little bit about these factors and what's influencing potential deal flow and valuation in 2024. So let's start with the deal flow and then I kind of gave it away, we'll talk about the valuation next.

Yes, sure. Absolutely. Well, maybe not a surprise given the slide that Devin just shared, there's been a decline in M&A activity for the last 2 years. That suggests a pent-up supply of companies that are looking for opportunity to sell their business and do an M&A transaction. It really follows that trend that Devin just highlighted. So we know there's a lot of private companies as well as companies in PE portfolios that have been looking for some green shoots, looking for more certainty, all of the things we've been talking about. That pent-up supply will drive some of that growth that Devin was referring to over the next 12 to 24 months without question, especially now that we are starting to see opportunity for a soft landing, more clarity on interest rates, et cetera. So that all makes a lot of sense. I think importantly, too, structurally for private equity groups, which as Devin referred to earlier, are a really big component of middle-market M&A. It's really become the fuel that many, many years ago, the public equity markets fueled that smaller, lower middle-market growth. That is not the case today. It really is private equity. They have a life, a structure to their funds, usually a 10-year fund, 5 to 7 years to deploy capital. When you lose 2 years like we did in '22 and '23, they have really a high interest -- they're not going to make bad decisions, but they have a high interest in deploying capital in selling assets, in raising their next fund. So there are a lot of structural as well as economic factors in sort of a pent-up supply of private companies that really bode well when you look at the sort of top factors for increasing deal flow, that resonate. And so more reason to be optimistic as we think about '24 and '25 M&A activity.

Thanks, Dave. Steve, I'm going to ask you to sort of cover some of these other factors we alluded to before, AI. Also we have a 2024 election. Can you just talk through some of these other factors for us?

Sure. I think as you just said on, there's a couple of factors that are appearing on as material influencers in our survey results this year that we probably wouldn't have seen a couple of years ago, AI, in particular, being one of them. Clearly, there's been a lot of excitement and really a fever in the headlines surrounding AI over the last 12 to 18 months. I think initially, it was all surrounding trying -- everyone trying to gain an understanding of what the capabilities might yield as well as the VC community largely funding some earlier stage start-ups. But I think we're increasingly seeing AI start to impact the middle market. So people are finding ways to leverage the technology to not only drive kind of cost efficiencies, but also provide some very significant operating leverage to their business in terms of enhanced efficiency. So I think that as evidenced here, roughly 1/4 of the respondents are indicating that they have a desire to either acquire an AI platform or AI capabilities within an organization. It's definitely going to be kind of fueling M&A activity this year. I have seen some people refer to 2024 as a year that kind of AI pivots from a theme of AI enthusiasm to AI impact. So we'll see if that plays out in the middle market. And then, Danielle, as you just mentioned, we also have the election coming up later on this year. So typically the kind of election like other things that create uncertainty tends to actually be a bit more of a damper on overall M&A activity because of the unknowns. So I think what this is telling us is that we're going to see a fair amount of M&A activity take place this year, perhaps in advance of the election in November. So some parties that are going to try and kind of get up and down in the market and execute a transaction before there's any real kind of noise or potential for noise in November so that they don't have to manage through that during a marketing process. But overall, a number of factors here that are perhaps kind of that go beyond -- a step beyond the broader macro indicators that are going to help kind of improve M&A activity in 2024.

Thanks, Steve. Devin, I'm just about to put you back on the hot seat right now with the next one. I don't know if you wanted to add anything here, but I think you'll have an opportunity here in a second when we're talking here about company value expectation -- company valuation expectations, excuse me. Why don't you go ahead and dive into this, Devin and tell us what you think that this is showing us and again, if our respondents got this right.

Well, I think if you obviously look at this, you see there's optimism around valuations. And clearly, that's an important ingredient as we've already been talking about to getting M&A done. But I think it's important to remember where we've come from. So the equity markets peaked in late 2021, and you had the Fed pivot, you had the war start. And so we headed into 2022 with really extreme uncertainty. Equity markets, if you look at the Russell 3000 as a proxy, declined by about 25% from the beginning of 2022 through September. And that generally corresponds with a recession outlook. That's the type of move you historically see when people are expecting recession. And at that time, talking to our institutional clients there was a large degree that thought we were heading pretty quickly towards a recession. Since the markets bottomed, we've actually rallied about 35% from below. And now the Russell 3000 is back to the high, today, this morning, is trading right at its all-time high. And so it just gives you that sense that we've had this really material round trip in valuations. And buyers' expectations always reset faster than sellers' expectations. And sellers' expectations are generally tethered to their previous high watermark. And so -- the good news is that we've had this really material move, but now we've come a lot closer to what I would argue are the highs. And so that's going to enable sellers to get back into a position where they can negotiate and buyers are obviously in a position where if they're looking at the interest rate curve and the macroeconomic environment, we had a good GDP number today, they're generally feeling better as well. So if you think about a bid-ask spread, it was incredibly wide through early 2022. It's been closing. And now we've kind of round-tripped back in the public markets as a proxy, we're right back to all-time high. So I think this data, we'll see kind of what actually happens from here because I think there's always a difference between expectations and market valuations. It's obviously difficult to predict the future on valuations. But having that optimism is important to think about moving forward on strategic decisions. So that's the way we're thinking about it right now.

Thanks, David -- thanks, Devin. And Dave, I want to turn it over to you and just talk a little bit about what Devin was just touching on, the buyer and seller expectations and disconnects and what you're sort of thinking there?

Sure. And I highlighted some things related to industrials where I spend more time. And you do see here pretty bullish perspective around valuation for industrials in this chart. Some of that is driven by those big mega-trends that we highlighted earlier. Some of it is related to very specific operational metrics and hurdles that some of these companies have cleared in the last few years that gives them, again, more clarity and more organic growth opportunities as we think about 2024. But what's very important, and that I think, Devin, really was hitting on is, is there -- can you find agreement between where a buyer and a seller rest on that valuation? Is there a gap? Very important in any process in any sector to -- for a company to be having conversations, whether it's a Citizens M&A adviser or another party, but finding someone who's an expert in their industry, who is an expert in M&A to help them understand the current environment and valuation expectations. So you start to educate the seller on what the environment is today, why valuation metrics may be up or down based on a variety of factors, and those go well beyond the specific broad macro factors we've highlighted today and you really start to delve into very specific company performance. One thing I can tell you, certainly, from my experience over now 30 years of M&A, for very high-performing companies, they get high multiples and significant interest in almost any environment. It's really the sort of companies in the middle that are performing about at industry standard, whose margins are about at industry standard, moderate growth, et cetera, where the dynamics around the haves and have-nots and the big multiples that you might hear at the country club that may or may not apply to another company. And so having those conversations very early around how to think about the value of your industry and then how the value of your company relates to the broader industry and where you fit in it is really important before you go to market so that you are better aligned with the likely inbound interest you'll receive from private equity or a strategic buyer. So that process is really important to kind of get everybody on the right page and be level set on what appropriate expectations are in the environment you're in and where your company fits along the spectrum of top tier, mid-tier or maybe somewhere below that. But happy to chat more about that as we think about 2024. And the different buyer universe, whether it's a strategic buyer and their synergies, what might be an international buyer looking for a domestic footprint, a number of factors that are beyond, again, this macroeconomic and broad sort of industry matters we've discussed, it can really influence valuation materially in an M&A process.

Thanks, Dave. I want to turn over to Steve for a moment, so he could just talk through some of the sector-specific valuations here, too. Steve?

Yes, sure. I mean, first, I couldn't agree more with some of the commentary that Dave was just providing. I mean, as you can see here, business services is a little bit kind of more balanced in terms of expectations here. But overall, there is a view where valuations will increase in the coming year. But as Dave was touching on, a lot of this and a lot of where we spend our time is focus on educating specific businesses and how we would expect kind of their particular business to be viewed by the market so what we've seen over the last kind of years and in some cases, for kind of best-in-class assets, we're seeing valuations kind of that were just as high as they were previously, and valuations have really held up whereas kind of 4 other businesses, perhaps they've certainly come down. So it's certainly a kind of market by which you really need to evaluate the individual asset and from there can provide kind of guidance to business owners in terms of what the market will bear. But we're definitely seeing kind of green shoots in terms of increasing valuations across the board.

Thank you. So those are all really great insights. I think we're ready to maybe take some questions here. Yes. So I want to say that we have more questions than we probably have time for, but we will try to get through as many as we can. And I also wanted to say that there's a lot of great resources available if you're interested in learning more, you should go to the URL on the bottom here, which is citizensbank.com/m&a-outlook. Again, a lot of great resources there. So with that, if you guys are good, I'm ready to take some audience questions. You guys are good for that? Okay. So I also want to say that after we finish some of them, I'm going to come back to you each and ask you for a 30-second key takeaway. So I want you to have that in the back of your mind. Okay. First question, how are you seeing EBITDA multiples trending through 2024 to establish pricing?

Maybe I'll start for a moment. I think there's an academic calculation of valuation based on interest rates and returns, which would suggest, given the current high interest rates, that overall multiples may be down and may be improving as interest rates come down over the next 12, 24 months as expected. And related to my earlier conversation, well, that is true. And certainly, any finance class you take will -- it's easy to improve the value of something as you decrease the cost of capital associated with that valuation metric. However, the real art of this -- that's the science. The art of valuation is far more complex. The science matters, but we're also looking at a stock market reaching all-time highs, that's influential. We're also, as talked about earlier, thinking about who the buyer is, the strategic fit, the other attributes that make a company more or less valuable in the eye of the beholder. So we know, for example, private equity groups that have significant interest in industrials that may very much want industrial distribution or niche manufacturing and we know strategic buyers that are looking for add-ons that provide new product categories or new geographies and finding companies buyers that covet the certain attributes of the companies you're working with can really drive M&A multiples outside of sort of the academic sense of what the calculation might suggest. And so that -- the science of it is one thing. The art is another. And so it makes it hard to answer the question in general. But based on the science, overall, with higher interest rates, you would expect lower multiples. And as interest rates start to come down, more opportunity for multiples to expand. However, there's a lot of art wrapped around that, that it's really more influential than a point or 2 on the interest rate.

One thing that I might just add on to what Dave was touching on. Certainly, there's a lot of kind of company-specific factors that really drive valuation. But we also can't kind of remiss and not speak to kind of the impact that just competition in any given market has in driving up valuations and multiples. So certainly, as we look at some of the broader results here in the survey, clearly, it looks like there's going to be significantly more M&A activity and the more parties that you have surrounding any particular transaction, the more enthusiasm there is, and that pushes valuations in many cases, above levels that you might kind of expect just purely based upon kind of the broader kind of as Dave alluded to, more academic methodologies in determining a valuation.

Thanks. Okay. I want to answer a question really quick. I'm just seeing as we go through ADGS, somebody asks what it means. It's Aerospace, Defense, Government Services just going back to that slide. So next question for you guys, what challenges in the 2024 M&A market are you keeping an eye on?

Well, real quickly, I would just highlight. I think we've seen intensity in regulatory review. I guess that's not specifically '24, but more recently in the last few years, certainly a heightened scrutiny around HSR, CFIUS and other regulatory matters. I would also say that the diligence in the number of parties involved in M&A transactions, the level of detail that both strategic and private equity groups go into today with all the various experts, of course, you've got your accounting, legal, M&A, but much below that, the HR and environmental and operations and just the level of scrutiny extends time lines and creates some amount of risk in any time is generally not your friend once you sign a letter of intent. So those dynamics are something that we try to drive timeliness and clarity around as aggressively as possible as an adviser, but it is some of those things, regulatory and other matters, you have to deal with the environment you're in. And it has created some challenges around timing and clarity around closing.

I'd just add one point that's going to be very much kind of company or sector-specific, but coming out of 2023, where business performance and results were certainly mixed across subsegments and even at the specific organization level, right? That certainly puts an increased spotlight on kind of trending from a financial perspective and other key KPIs and that's certainly something that there's a lot of conversations for certain organizations in terms of, okay, when does it actually make sense to launch in 2024 relative to that business performance. So kind of that's one element, too, that I think will impact M&A for certain organizations. Clearly, that's not something that's a factor across the board.

The only thing I would add there is the macro. The macro has been such a driver of sentiment, and there's been such extreme moves over the past 2 years. And so right now, that sentiment, as we've talked about in the conversation today is in a much better place. But the one thing we also appreciate is the degree of change that we've just gone through and potential for more change from here. So I think there's still that lingering aspect of things could change again. And even though confidence is rebuilding, it's fragile. And so I think that's really kind of the question mark of navigating this year from a macro perspective what happens with interest rates. I think it's just a stable interest rate environment will be favorable. We don't need to see the full degree of the Fed cuts that are maybe in the curve today. But I think there's still quite a bit of uncertainty around some of these really big factors and more so than you would say is normal. So that is still something that is kind of looming out there.

Okay. Next question. If you actually think back to -- sorry, this was in relationship to a slide that we had, which was the one, when do you think M&A activity will pick up, and it was like 54% for the PE firms. Somebody is actually asking, do you think that's the first sign of froth in the market?

No. I wouldn't necessarily say that we're anywhere near a point of feeling a lot of froth in the market right now. So I think that we're expecting a rebound, if you will, in terms of M&A activity, but we're not anywhere near what we were seeing in 2021, where you could argue that there's some froth in the market at that point in time just given all that activity level. So we've got a ways to go.

If you look at PE announcements, you'd have to increase 115% for sponsors volume just to get back to a trend line, let alone anything frothy. So essentially, you could more than double their level of activity from 2023, and you would just be at a long-term average of activity. And then you put that against the record amount of dry powder. The relationships are way out of balance right now. And you can see really material recoveries without really getting to anything that is close to what you would call frothy.

Okay. Last question I'm going to ask here. Will the role of the M&A adviser change in 2024? If so, how do you see it changing?

Yes. I don't think -- I've been doing M&A, as I mentioned, since 1992. And the reality, finding an M&A adviser you trust, who knows the industry, has significant M&A experience is critical if you're going to be successful. Actually, I'm stealing my 30 seconds actually, that's what I was going to highlight. But anyway, that's critical to the success of M&A. Build those relationships early, find people that have their finger on the pulse that are active in your sector that are -- that also goes to lawyers and accountants and other advisers, building that is important. So being a trusted adviser, being someone that you can, as a company reach out to, finding that person, that team, that firm is important and doing it well before you intend to execute M&A is really a best practice. I don't know for our colleagues there may be some nuances. I've done this for 30 years, so it's like the old dog. There's probably some new tricks Steve may have up his sleeve.

I mean in terms of the most important factors. No, I don't think that you'll see things change, right? I think that particularly in environments like what we've been experiencing in 2023, coming out of that into 2024, it's all that more critical that your adviser really understands the fundamentals of your business, can really identify because of their experience in the segment, how your asset may be differentiated relative to your peers so that they can come up with very compelling positioning. And then on top of it, have established relationships with the buyer community, both on the strategic side as well as the financial sponsors that play in that particular sector so that they can run a very high-touch process, whereby they're kind of individually pitching, if you will, your asset relative to others that may be in the marketplace. And I think that that's critical in an environment like we're in right now, where you're not just seeing kind of deals get done left and right. There's a lot more one-on-one selling that's required in order to have a successful outcome and certainly to drive a premium multiple for your business. So I wouldn't necessarily say that's new to 2024, but it's certainly a critical element here in this market environment.

Thanks, Steve. So I just want to take a minute to thank all 3 of you for really sharing your insights. I also want to thank Citizens for giving us this great outlook report every year that we can look at as we look for the future of the year. And with that, I know we only have a couple of minutes left. I want to go around and kind of put each of you on the spot. What are your key takeaways? What are you thinking about as you look at transacting in 2024? So Devin, why don't we start with you?

Sure. Well, first off, great to do this. Great to be here and really enjoyed the conversation. What I would say is that it's always good to have historical context. And we went from kind of this perfect environment in 2021 to the last 2 years kind of the complete opposite. But the last 2 years have been an aberration as much as 2021 was an aberration. And so our view is that 2024 into 2025 is a transition year and you will see improvement. I think the optimism from the survey really hits on that. But M&A is an important strategic tool for companies and sponsors and there's a long-term secular growth underpinning to it. And hopefully, that came through today. And I also think that if we're in a higher interest rate environment for longer, you're going to see a lot more rational behavior. And so that's actually going to be really healthy. The M&A that happens will be high-quality transactions. So I do think we're normalizing. We're not going to go from where we are today to a normal environment overnight, but it's a process and the process is underway.

Great. Steve?

Sure. I'll try to not be repetitive there. But in general, I think probably safe to say by the commentary on this call, we're all excited for what 2024 will bring, be able to put 2023 in our rearview mirror. Overwhelmingly, the sentiment is definitely that the market environment will improve. I also think it's important for anyone that is contemplating a transaction, if there is a real need to transact in 2024, to kind of prepare even in advance of when you think that window may explicitly be open in order to try and be on the leading edge of businesses and your subsegment to go-to-market as opposed to running the potential that you face a crowded market later on in the year. But overall, I think kind of that additionally helps in the mindset of the election in November. So being able to get out ahead of any potential turbulence at that point in time. But overall, I think we're excited for 2024 and anticipate a lot of healthy market activity.

Thanks, Steve. And Dave?

I will close that out just by reiterating the importance of building a team, both internally and externally. The value of that is significant in being successful in M&A, whether you want to be a buyer or a seller, finding experts, finding teammates within your organization, incorporating it in your business planning and strategy and quarterly reporting, monthly, whatever that metric is, incorporating it in your day-to-day activities and being very -- being able to converse in the language of M&A what you want to accomplish, setting goals and objectives. Those best practices make for much smoother, better executed acquisitions, divestitures or sale transactions.

Thank you, Dave. Once again, Devin, Dave, Steve, thank you so much, and thank you for Citizens for presenting this outlook to us. On behalf of ACG, thank you to everyone for joining us today. Have a great day. If you want to download the full report, please go to citizensbank.com/m&a-outlook. Thank you. Have a great day, everyone.

Thank you.